Regulatory Changes in the Investment Banking Industry How investment banks can prepare themselves to cope with evolving regulations

Regulatory Changes in the Investment Banking Industry How investment banks can prepare themselves to cope with evolving regulations

1. Introduction

Although the worst might be over, the investment banking industry is still recovering 
from the aftermath of the financial crisis. The post-crisis period has witnessed a flurry 
of regulatory activity, with more stringent and intrusive regulations being the order of 
the day. Some of the regulations whose provisions are going to have an impact on 
one or more aspects of the investment banking industry include:
•     The Dodd-Frank Act
•     Basel III
•     Markets in Financial Instruments Directive (MiFiD)
•     European Banking Authority (EBA) Governance Guidelines
•     Financial Stability Board (FSB) Principles
•     European Market Infrastructure Regulation (EMIR)
•     Foreign Account Tax Compliance Act (FATCA)
•     Financial Transaction Tax (FTT) Act 
The scope and geographical relevance of these regulations might differ, but all 
of them mandate the imposition of more stringent regulatory norms on financial 
institutions. All aspects of the investment banks’ business—capital, liquidity, systemic 
risk, supervision, governance, remuneration, traded market—are expected to be 
affected by one or more of provisions of these evolving regulations. 
This whitepaper will look at the impact of evolving regulations on the investment 
banking industry and will provide some high-level guiding principles for coping with 
the new regulatory environment.

2. Overview of the Investment
Banking Industry

The primary activity of investment banks is client servicing, which includes 
helping clients raise equity capital by underwriting initial public offerings and 
facilitating private placement of shares, raising debt capital, facilitating mergers 
and acquisitions, and managing investments. Investment banks are also involved in 
ancillary activities such as proprietary trading, investing, and the development and 
sale of equity and debt products. 
Typically, an investment bank has a three-layered structure comprised of front, mid, 
and back offices, though there can be variations based on the size of operations. 
The front office is involved in activities such as assisting organizations in mergers and 
acquisitions, providing investment management services to institutions and high net 
worth individuals, formulating strategy, and developing investment research reports. 
The typical functions of the mid-office are risk management, equity research, internal 
strategy development, organizational controls implementation, and compliance with 
regulatory norms. Finally, the back office is tasked with maintaining trading platforms, 
devising new trading algorithms, handing trade confirmations, and ensuring correct 
execution and settlement of securities.
2.1. Financial Performance 
While revenues registered by investment banks improved between Q2 2012 and 
Q1 2013, the industry has suffered an approximate decline of more than 30% in 
revenues between 2009 and 2012
. The major reason for this sharp drop is the 
decline in business from their clients with income from trading bonds, currencies, 
and commodities. These areas have suffered because of the discouraging impact 
that slowing economies and turmoil in Europe have had on institutional investors. 
Another major reason for the drop in revenues are regulations governing capital and 
liquidity, which are reducing returns earned by banks and are forcing them to shrink 
their balance sheets and cut back on trading. 
Nevertheless, there have been some bright spots on the profitability front with some 
leading investment banks having reported higher than expected profits in the first 
quarter of 2013. For example, the pre-tax profit of Barclays’ investment banking 
unit rose by 11%
 and Nomura’s first quarter profits more than tripled from last year, 
owing to a surge in the investment banking fees and brokerage commissions. 
From a regional perspective, the U.S. continues to remain the key region for the 
investment banking industry, and accounted for around half of the industry’s 
revenues in 2012. However, the revenues of the investment banking industry declined 
across most regions between the fourth quarter of 2012 and the first quarter of 
2013, with the U.S. region witnessing a decline of 6.1% in revenues. The primary 
reason for the drop in revenues was reduced activity in mergers and acquisitions 
which declined from $303.9 billion in the fourth quarter of 2012 to $239.4 billion in 
the first quarter of 2013. Mergers and acquisitions activity witnessed a decline in 
Asia and Latin America too, thereby resulting in the decline of their revenues for the 
same period.

Regulatory Changes in the Investment Banking Industry How investment banks can prepare themselves to cope with evolving regulations